It seems as if City analysts are unsure whether Aviva’s (LSE: AV) £5.2bn merger with Friends Life (LSE: FLG) is a good deal or not. And there’s one sticking point that’s making most analysts scratch their heads — Friends’ exposure to the UK’s life assurance market.
Pension reforms
Last year’s pensions reforms completely changed the UK’s life assurance market, and annuity sales slumped in the months following the overhaul. Friends Life did not escape unscathed.
Falling income at the group’s UK retirement income business hit operating profits during the first half of last year. Operating profits for the period fell 7%, from £171m to £159m, and Friends Life faced calls to spin-off or divest its retirement income business as a result.
Nevertheless, there’s more to Friends Life than just annuity sales, but Aviva’s target is the potential cost savings and merger synergies that can be achieved from the deal. In particular, Aviva’s management is planning to produce £225m a year in cost savings once it acquires Friends Life, while there will also be increased benefits to customers as lower costs allow the enlarged group to offer more for less.
Merger and integration costs are set to total £350m, of which £200m will be incurred next year. As part of this plan, Aviva’s management has stated that the group may cut as many as 1,500 jobs by the end of 2017.
Hopefully the size of the enlarged Aviva will attract customers seeking security, as the merged entity will have greater financial firepower than either standalone company. This should increase sales.
Additionally, Aviva’s cash generation will increase after the deal and the company will be able to pay down debt at an accelerated rate — the all-stock nature of the transaction means that the merger will not have an effect of Aviva’s debt level. Friends Life shareholders will own 26% of the enlarged company.
Slow growth
Unfortunately, despite cost savings and an improved product offering from the combined Aviva/Friends Life company, City analysts don’t expect the deal to have much impact on the group’s earnings going forward. For example, they have pencilled in 2016 earnings per share of 55p for the enlarged group. This forecast is only 17% higher than the figure Aviva is already expected to report for full-year 2014.
Still, projected EPS of 55p for 2016 indicate that Aviva is currently trading at a 2016 P/E of 9.3, significantly below Aviva’s peers in the life insurance sector, which currently trade at an average P/E of 16.
Based on this figure, if Aviva’s shares moved to trade in line with peers by 2016, the shares could be worth up to 880p by 2016. If the company’s deal with Friends Life goes smoothly.
